The U.S. Securities and Exchange Commission handed down a $24 million slap on the wrist to Block.one for allegedly selling unregistered securities in its $4 billion ICO, begging the question: what would be an appropriate settlement with Ripple Labs, which conducted an “ongoing ICO”, as Ripple’s release of XRP has been labeled in an ongoing California lawsuit.
The defendants have strongly denied the allegations.
The SEC’s use of the 1946 Howey Test to determine what constitutes a modern-day security, in combination with its ‘regulation-by-enforcement’ activities, has created less clarity around its attitude to digital assets than a fireside chat with Chairman Jay Clayton.
Its decision to whack a 0.6 percent penalty on Block.one for the EOS ICO, in a settlement with a Hong Kong-based company that specifically sought to exclude Americans from investing (and which was not required to admit or deny guilt or wrongdoing) is almost unfathomable.
Did Block.one do something wrong, or not? If so, why the tiny penalty? If not, why levy a penalty at all? Was their infraction minor – in which case, is Howey not binary, as we had previously thought?
Rather than offer any guidance, clarity, or even serious rationale for their actions, the SEC has once action clouded the crypto skies: so what is any project supposed to infer from this decision?
Hypothetically Speaking: A Ripple Settlement?
The SEC seems to have two methods by which it can provide assurances to a jittery token industry. One is through a settlement process, as EOS enjoyed, and the other is through its No-Action letter process, which affords a company confidence that the regulator will not take enforcement action against it.
TurnKey Jet received such a letter in April, meaning it could proceed with its crowd sale provided its tokens were only used to help people book seats on private jets. If the company remains in compliance with those stipulations – notwithstanding whatever promises it made or the manner in which it conducted its public sale – it would not be pursued by the Commission.
Ripple Labs has no such letter, to our knowledge.
Ripple is an unabashedly American company. Its website is accessible in the United States. In fact, users “located in, under the control of, or a national or resident of any country to which the United States has embargoed goods or services…” are expressly identified as being denied access. The website for XRP uses the URL “www.ripple.com/xrp” and a Google search for ‘XRP’ only shows the Coinbase website above Ripple’s site.
Block.one is registered in the Cayman Islands, and is headquartered in Hong Kong, although it has a U.S. presence. Investing in its ICO was forbidden for Americans, yet, according to the SEC, some did anyway.
The SEC described Block.one as selling ‘a portion’ of its tokens to US investors. However, Block.one also avoided promising returns to investors, another trigger the regulator warns against.
Calculating Ripple’s Jeopardy: The 0.6% Howey Penalty
At Crypto Briefing we thought we would make an attempt to use the EOS ruling to measure the potential settlement the SEC might reach with Ripple Labs, the promoter of XRP and the coins formerly known as Ripples – IF a settlement were on the cards.
In this hypothesis we’ll begin with a “presumptive penalty” of 0.6 percent of the total funds raised as a ‘Claytonian basis’ for calculating appropriate fines.
We should note here that while EOS raised approximately $4 billion in its ICO, research conducted by The Block suggests that Ripple Labs has ‘only’ raised $1.14 billion since Q4 2016. EOS’ market cap is currently at $2.76 billion, but XRP is at $10.8 billion based on the current circulating supply.
Since the majority of the non-circulating supply is locked in escrow for Ripple Labs, we will generously consider that their ‘raise’ includes the remainder of that supply at the current price: in other words, approximately 49 billion XRP, currently valued at $12.3 billion.
In total, therefore, we can assume that Ripple Labs’ benefit from previous XRP sales, combined with future sales at the current price, comes to a total of $13.44 billion.
The Argument Against A Penalty
In its motion to dismiss the lawsuit against it, Ripple Labs and Brad Garlinghouse’s lawyers assert that XRP coins are not securities, but have been deemed virtual currencies in a federal case against Ripple in 2015:
“In fact, as recognized by the U.S. Departments of Justice and Treasury in 2015, XRP is a “convertible virtual currency. It is correctly characterized as a currency under applicable law and, as such, need not be registered as a security under federal and state securities regulations.”
– Attorneys for Ripple Labs and Brad Garlinghouse, California District Court, August 5, 2019
Let’s accept this conclusion for the sake of argument. Good news for Ripple fans.
A Paragon Of Virtue
What if the class action prevails?
As an American company that freely and openly sells XRP on regulated exchanges to Americans, and that even forbids access from countries deemed hostile to American interests from accessing its web assets, it appears to be exposing itself to American investors, possibly bringing XRP directly to the jurisdictional shores of U.S. regulators.
Because of that, we propose it may sit in a position more similar to that of Paragon or Airfox, both of which were ICOs that settled with the SEC by agreeing to return funds to harmed investors.
Uh oh. We must remember that those projects were specifically identified as conducting ICOs after the Commission warned that crypto offerings could be construed as securities in its DAO Report of July 2017.
So there are two potential outcomes here –
1 – Ripple successfully grandfathers in its ICO, arguing that it was conducted (i.e. all tokens were minted) before the DAO warning – in which case, penalty ZERO.
2 – Ripple is found to be conducting an ‘ongoing ICO’ as it continues to release XRP tokens to retail investors through its billion-a-month escrowed supply. In which case, game over.
Returning 43 billion XRP tokens to Ripple Labs: over $10 billion at current prices.
Brad, Don’t Make Any Prom….. Ah! Too Late
Ripple Labs also has a language problem. Last month CEO Brad Garlinghouse downplayed bitcoin’s utility as a payments solution, especially versus XRP. He told CNN:
“The long-term value of any digital asset is going to be derived from the utility it delivers.”
– Ripple CEO Brad Garlinghouse on CNN
— Julia Chatterley (@jchatterleyCNN) September 12, 2019
The implication here is that XRP has utility. And Garlinghouse specifically says that utility drives value. Therefore, XRP should be expected to grow in value. This is dangerously close to what the SEC could conceivably regard as constituting a promise of capital growth. (Not to mention, current guidelines suggest that creating tokens for the express purpose of building a network is also a major no-no.)
Crypto Briefing has previously given a good deal of thought to ‘The Satoshi Test‘, a modern interpretation of Howey that we believe illustrates that Ripple Labs has engaged in a systematic attempt to reorient its business model to escape classification as a security. (As we often suggest, Preston Byrne’s analysis of this subject is currently what we consider definitive.)
So again, let’s imagine two scenarios.
If Ripple Labs is willing to settle with the SEC on similar terms to those apparently negotiated by EOS (0.6% of fund raised, the ‘Claytonian basis’), we might suggest that doubling that fine (for clearly selling to US investors) and then doubling again (for suggestions of value appreciation) would result in a 2.4% fine based on the amount raised.
Potential fine: $13.44 billion raise x 2.4% = $322,656,000.
Since Ripple has been unlocking a billion tokens per month recently, awarding themselves around $8,533,000 PER DAY, that fine that might take almost 38 days to pay off.
And while Clayton’s brain is a difficult one to understand, we believe Ripple has ruffled some of the feathers that tickle it: don’t be an American company, don’t sell tokens to Americans, don’t make price promises, and stop selling tokens after the DAO report.
Hopefully, this is a helpful launching pad for Jay Clayton to begin forming a settlement with Ripple.
Assuming it hasn’t already been handled by the former SEC Chair the company hired to defend themselves.
Additional research and commentary by Jon Rice